When Is it a Good Time to Take Out a Home Equity Loan?

A home equity loan makes sense when you need affordable credit and can take on the risk of a secured loan.

You should obtain a home equity loan when you need credit and the interest savings advantages of a secured loan outweigh the associated risks. Common uses for home equity financing include college, home improvements, vacations, auto financing and other projects.

Basics

Home equity is the difference between the value of your home and the amount you owe on a first mortgage. Often called a second mortgage, you can use your home's equity to borrow through a home equity loan or home equity line of credit (HELOC).

Benefits

Because you use your home as collateral, as with a first mortgage, you get better interests rates on equity loans than you would with unsecured loans. This interest savings reduces monthly payments and adds up over time. Some people use equity financing in lieu of auto loans because home equity loans have tax deductible interest.

Risks

You are taking on another lien against your property should you fail to repay your loan. Equity loans are lump sums like mortgages that you pay off in fixed amounts over a period of usually 15 years.

HELOCs are like lower interest credit cards but typically require only interest payments during a 10-year "draw period." This causes some people to never pay on principle until the draw ends and your credit balance is amortized.

References

• Bankrate: What Home Equity Debt Is
• Federal Reserve: What You Should Know About Home Equity Lines of Credit